Duff & Phelps Credit Rating Co. (DCR) recently discussed its methodologies for evaluating loan servicing, particularly its criteria that affect the performance of residential mortgage-backed securities.
The event was conducted by Henry Hayssen, RMBS group vice president for DCR, in which he said, "Mortgage servicers who are especially adept in controlling delinquencies and loan losses will be valuable to investors, especially in a period of economic downturn." He added that the servicer is on the "front line in controlling pool performance" by being able to minimize the number of mortgage delinquencies, finding alternatives to foreclosure and reducing loss severity to the lowest possible level.
Hayssen said that it is the servicer who maintains a continuous cash flow to investors, because, "Each month, it collects payments, remits them to trustees, and reports on full performance to the trustee, who in turn passes payments on to the bondholders."
Therefore, DCR has designed three evaluation processes that can help determine the effectiveness of servicers to service loans. In each evaluation, DCR reviews the entire loan servicing process, complete with on-site visits and an analysis of materials submitted by the servicer. An analysis of servicer's corporate structure, performance of the loan servicing portfolio, and the operations of the individual departments all take place during the evaluations.
The first evaluation is a transaction review, which is "to ensure that the servicer is capable of handling the portfolio and a manner to measure it with securitization standards," said Hayssen. "It is a general review assessing general capability."
The second, servicer accreditation, "evaluates the overall effectiveness of the servicer in handling a specific loan product, together with an assessment of the servicer's financial condition," he said. "It is meant to establish the gold and platinum standards." He noted that additional evaluations are conducted based on loan products ranging from prime and subprime loans to FHA and master service loans. Time is also spent monitoring the servicer's staff and reviewing management documents.
"DCR's servicer accreditation is public recognition and validation for a company's ability to effectively service mortgage loans in all aspects of their operation as well as a vote of confidence in the company's management, long-term viability, and resources," Hayssen said.
The third type, the special servicer designation, addresses a servicer's ability and effectiveness in loan default management. "That is bringing delinquent borrowers current, finding alternative resolutions to foreclosure, and for those loans that do result in property liquidation by the servicer, aggressively managing foreclosure and REO timelines," he added. "DCR expects the special servicer to have highly focused staff, skills and technology to support these activities."
Areas to Watch
In addition to the three types of evaluations, Hayssen addressed four "critical areas" that DCR has looked at that should be of concern to the market: financial strength and viability, management and staffing, loan administration, and the entire default management process.
"While mortgage-backed securities can last for 30 years, mortgage pools are at greatest risk of occurring loss in the first seven years," he said of financial strength and viability, adding that there are few servicers with a corporate debt rating because many of them do not issue debt. Viability can also be affected by characteristics that do not appear on financial reports.
For management and staffing, DCR looks for solid industry experience, two to three years of operational experience, not only to examine mortgage performance, but to see how teamwork is building among the servicer's staff. Depth and diverse skills are also monitored to get alternative viewpoints on issues.
Loan administration is what Hayssen called the least glamorous, but most critical. Two areas making up loan administration are cash management and loan setup. "Cash management is like air, you don't notice it until there is a problem," he said. "The more problems there are in a portfolio, the more important cash management is."
Loan setup is when data first enters the servicing system. This is important because the data is needed to allocate the funds correctly, and produce documents needed for foreclosure.
The fourth area, default management, is "where the rubber meets the road for the credit analyst," Hayssen said. This area, which has become technology-driven in its collection process, is to collect on delinquent loans, find alternative resolutions that can mitigate losses, and manage the timeline through bankruptcy, foreclosure and real estate owned (REO).
"If you can shorten one year off the timeline by reducing exceptions to the foreclosure process, at today's interest rates, on a prime loan, you just cut severity by 8% and on a subprime loan anywhere from 12% to 14%," Hayssen said.